Fortnightly - United Illuminatinghttp://www.fortnightly.com/tags/united-illuminating
enAnomaly or New Normal?http://www.fortnightly.com/fortnightly/2013/11/anomaly-or-new-normal
<div class="field field-name-field-import-deck field-type-text-long field-label-inline clearfix"><div class="field-label">Deck:&nbsp;</div><div class="field-items"><div class="field-item even"><p>Regulators weigh interest rate climate and future Fed policy in setting allowed return on equity.</p>
</div></div></div><div class="field field-name-field-import-byline field-type-text-long field-label-inline clearfix"><div class="field-label">Byline:&nbsp;</div><div class="field-items"><div class="field-item even"><p>Phillip S. Cross</p>
</div></div></div><div class="field field-name-field-import-bio field-type-text-long field-label-inline clearfix"><div class="field-label">Author Bio:&nbsp;</div><div class="field-items"><div class="field-item even"><p><span class="s1"><b>Phillip S. Cross</b> is <i>Fortnightly’s</i> legal editor, and serves on the editorial staff of PUR’s </span><span class="s2"><i>Utility Regulatory News</i></span><span class="s1">, reporting weekly on state ratemaking and regulatory decisions.</span></p>
</div></div></div><div class="field field-name-field-import-volume field-type-node-reference field-label-inline clearfix"><div class="field-label">Magazine Volume:&nbsp;</div><div class="field-items"><div class="field-item even">Fortnightly Magazine - November 2013</div></div></div><div class="field field-name-body field-type-text-with-summary field-label-hidden"><div class="field-items"><div class="field-item even"><p>By the term “anomaly,” we don’t mean “Armageddon.” With the government shutdown recently lifted as this issue was going to press, we offer no prediction on how the continued sense of budget uncertainty and risk of future U.S. credit default might affect utility rate making and cost recovery.</p>
<p>Rather, this year’s annual survey of retail rate case orders and the rates of return on common equity (ROE) authorized therein prompts a question much less worrisome, though no less urgent:</p>
<p>Should the historically low interest rates of the past several years require a haircut to the ROEs authorized for regulated electric and natural gas distribution utilities in rate cases now being decided, or does this credit climate represent an historical anomaly – one that should call into question whether today’s rate-making methods, which for years have remained largely unchanged, are still producing the right answers?</p>
<p>Here, as in every survey, we provide data from all major electric and natural gas rate case orders. But we also take a look at three new rate case opinions from the past year that address the question of Anomaly vs. Normal: one from Connecticut, one from Alabama, and one from the Federal Energy Regulatory Commission (FERC).</p>
<h4>Rate-Making Methods</h4>
<p>Over the past several years, the <i>Fortnightly’s</i> annual November rate case survey has revealed a continued reliance on the discounted cash flow (DCF) model as the touchstone for ROE determinations. Other methodologies are considered, however, and in the end most commissions inform us that the process is as much art as science, with the goal being to balance the evidence and apply sound judgment to produce a fair rate of return.</p>
<p>Wrangling over technical aspects of financial modeling comprises the lion’s share of the record, but the essential question remains the same: what figure will give the utility a fair chance to attract equity capital?</p>
<p>Under traditional rate-base and rate-of-return regulation, investors are thought entitled to earn a return that falls within a “zone of reasonableness.” And as further defined by federal and state courts, a fair rate is one that is sufficient to attract capital on reasonable terms and high enough to enable the utility to maintain its financial integrity.</p>
<p>One way regulators have approached the question is to begin by looking at how much an investor would earn by purchasing a so-called risk free investment, generally measured as the interest rate on U.S. Treasury bills. Rates for these instruments have remained low for several years, and encouraged to stay low by a Federal Reserve dedicated to easing credit and boosting the economy.</p>
<p>This climate has led those seeking higher ROE awards to argue that the current interest rate trend is anomalous – that recent indications suggest the Fed will soon rework these near-zero coupon rates and ratchet them upwards, possibly to tamp down any inflationary pressures as the economy begins to recover from the Great Recession.</p>
<h4>Three August Viewpoints</h4>
<p>In August, in a widely watched case, FERC Administrative Law Judge Michael Cianci chose to ignore claims that the current interest rate climate<br />climate is somehow anomalous.</p>
<p>He rejected expressly any argument that “these unusual financial and economic times” must render the traditional ROE analysis obsolete, but conceded that on appeal the full commission would be “free to consider any policy decisions it believes are warranted.” <i>Martha Coakley v. Bangor Hydro-Elec. Co. et al., Docket No. EL11-66-001, Aug. 6, 2013, 144 FERC ¶63,012, at ¶549.</i></p>
<p>The judge ruled that FERC precedent required strict adherence to results of the DCF method of financial modeling in setting the base ROE. That finding led the judge to rule that the current 11.4-percent base-level ROE (shorn of all incentive adders) that has long applied to network transmission service provided by ISO New England across the six-state region over lines owned by New England’s electric transmission owners (NETO) is unreasonable and unlawful under existing capital market conditions – <i>i.e.,</i> declining yields for Treasury and public utility bonds. (<i>For more detail on the case, see “</i> <i>Investor Sequester</i><i>,” this column, June 2013, <a href="http://www.fortnightly.com/fortnightly/2013/06/investor-sequester">http://www.fortnightly.com/fortnightly/2013/06/investor-sequester</a>.</i>) </p>
<p>But if lower ROEs are indeed the new normal, what might we expect in terms of utility growth?</p>
<p>Often, claims on whether a rate is high enough to attract and hold investors over the long term are simply left to stand on their own. Or, they are sometimes buttressed only by statements regarding the effect on future credit ratings an ROE award might make. Accordingly, it’s interesting to note that Judge Cianci in the FERC proceeding assigned “moderate probative value” <i>(144 FERC ¶63,012 at ¶576)</i> to a study purporting to show that if ROE is set substantially below 10 percent for long periods of time it could negatively affect future investment in NETOs. </p>
<p>On the other hand, <i>Fortnightly</i> Editor Michael Burr reported in last month’s issue that regulated utilities succeeded in raising near-historic amounts of debt capital during the period since 2008, with such success attributed at least in part to favorable regulatory treatment at the state level. (<i>See, “</i> <a href="http://www.fortnightly.com/fortnightly/2013/10/five-years-later"><i>Five Years Later</i></a><i>,” October 2013.</i>)</p>
<p>In another case handed down in August, involving United Illuminating, the Connecticut Public Utilities Regulatory Authority (PURA) also reviewed conflicting arguments on whether historically low Treasury bond rates would remain, or would be pushed higher soon by evolving Fed policy. Connecticut decided, for the most part, that low interest rates would continue for the foreseeable future, justifying an authorized ROE of 9.15 percent – up from the prior rate of 8.75 percent, but lower than UI’s request of 10.25 percent. <i>(United Illum. Co., Conn.PURA Docket No. 13-01-19, Aug. 14, 2013.)</i></p>
<p>In other words, the lesson from Connecticut was mixed.</p>
<p>On one hand, the PURA warned us not to assume that continued low interest rates would guarantee the company’s continued positive financial performance. Such “presupposition is inappropriate,” it noted. Yet the PURA sided with the state’s Office of Consumer Advocate that achieving a 6.5-percent national unemployment rate – a benchmark that could trigger a new, less expansive monetary policy from the Fed – appeared unlikely in the near future.</p>
<p>A somewhat contrary view comes from the Alabama Public Service Commission in a third decision issued in August. In a case involving Alabama Power, the PSC rejected allegations that current economic conditions (<i>i.e.,</i> low interest rates) indicate reduced expectations by utility stock investors. <i>(Alabama Pwr. Co., Ala.PSC Docket Nos. 18117, 18415, Aug. 21 2013.)</i></p>
<p>The PSC rejected claims that the utility’s then-current authorized ROE range of 13 to 14 percent was too high given the persistently low interest rates seen in the market. It rejected a 10-percent compromise ROE that was proposed by consumer advocates and based on traditional analyses using the DCF and CAPM (capital asset pricing model) methods.</p>
<p>Instead, the PSC found the current low interest rate climate anomalous, as argued by the utility.</p>
<p>The commission added that while a consumer advocate witness had noted a downward trend in allowed returns, he had neglected to acknowledge an offsetting increase in common equity ratios among utilities over the same period.</p>
<p>As the PSC noted, the consumer advocate’s argument was based in part on “an unsubstantiated conclusion that the current environment of ‘artificially low’ interest rates represents normal conditions for the foreseeable future.”</p>
<p><a href="http://www.fortnightly.com/sites/default/files/article_uploads/1311-CW-fig1.pdf" target="_blank"><strong>Download Figure 1: <span style="line-height: 1.538em;">2013 Rate Case Study in pdf format here.</span></strong></a></p>
<h4>Notes to the figure:</h4>
<p>* Settlement agreement ROE not specified.</p>
<p>NA = not available</p>
<p>1. Utility operates under a rate stabilization and equalization plan – an alternative rate-making mechanism that provides for periodic automatic adjustments to rates to maintain ROE within a specified range.</p>
<p>2. Equity ratio capped at 55 percent. Down from 60 percent per order dated 12/01/2009.</p>
<p>3. Order establishing return on equity, return on rate base and resulting reductions in revenue requirement for the state’s major energy utilities.</p>
<p>4. On March 21, 2013, commission issued an order approving a settlement agreement resolving Phase II issues setting benchmark indexes for subsequent adjustments. Re: Southern California Edison Co., D.13-03-015, 304 PUR4th 296 (2013).</p>
<p>5. General rate case proceeding. Findings limited to revenue requirement issues. ROE considered in separate generic docket, D.12-12-034, as shown.</p>
<p>6. General rate case proceeding. Stipulated revenue requirement shown.</p>
<p>7. Allowed ROE reflects reduction from stipulated figure of 10 percent. Reduction composed of 0.5 percent attributed to lower interest rates and 0.5 percent due to over-curtailment of renewable energy by utility.</p>
<p>8. Annual formula rate plan update.</p>
<p>9. Initial order issued 2/3/13. Re: Indiana Michigan Power Co., 303 PUR4th 384 (2013). Figures shown reflect subsequent updates.</p>
<p>10. Company operates under earnings sharing rate plan.</p>
<p>11. Utility operates under formula rate plan. Figure shown is midpoint of earnings range approved by the commission.</p>
<p>12. Commission finds no significant factor that would justify a radical departure from 9.31 percent ROE granted in prior rate order dated 7/20/12, as suggested by the utility.</p>
<p>13. Pursuant to settlement agreement submitted in period evaluation proceeding under the utility’s rate regulation adjustment plan.</p>
<p>14. ROE not stated. Commission finds overall rate of return of 7.39 percent, given its benchmark range of 8 to 26 percent for ROE under its formula rate plan.</p>
<p>15. Company agrees to eliminate its existing infrastructure system replacement surcharge and roll amounts collected into base rates. Surcharge reset to zero.</p>
<p>16. Figure shown as stated in final order on rehearing. Original order set ROE at 9.8 percent for Southern Nevada and 9.2 percent for Northern Nevada.</p>
<p>17. Docket concerning application for approval of a four-year infrastructure improvement program. Increase shown is total approved cost exclusive of allowance for funds used during construction (AFUDC). ROE on capital investment set at 9.75 percent for ratemaking purposes. Separate AFUDC carrying cost rate set at 6.9 percent.</p>
<p>18. Order extending terms of current rate plan for two additional years. Earnings sharing (80/20; ratepayer/company) begins when earnings reach figure shown.</p>
<p>19. Merger application resulted in two-year rate freeze with no change in allowed ROE. Earnings sharing threshold reduced from 10.5 percent to 10 percent.</p>
<p>20. Earnings sharing mechanism. 50/50 sharing begins when earnings reach ROE shown.</p>
<p>21. Distribution service only.</p>
<p>22. Revenue deficit calculated per demonstrated actual earnings of 9.32 percent.</p>
<p>23. Benchmark ROE under utility’s performance-based rate change plan.</p>
<p>24. No change in base rates indicated per annual earnings review.</p>
<p>25. Parties to settlement agreement unable to agree on specific values for cost of capital components. Figure shown listed as “notational value.”</p>
<p>26. Approved in rate case decided in 2004.</p>
<p>27. No previous PUC-approved ROE. Company was recently formed to provide transmission for wind powered electric facilities.</p>
<p>28. Two-step increase: $37 million on 5/1/13; and $13.8 million on 9/1/13.</p>
<p>29. A single two-step increase: $100 million on 10/12/12; $54 million on 9/1/13.</p>
<p>30. Major portion of utility’s request includes claims related to under-recovery of purchased power costs. In addition to base rate increase shown, utility is authorized to implement a surcharge to recover $239,046 for payment of arrearages owed to power supplier.</p>
<p>31. Total revenue increase. Application filed in two steps. Initial increase of $32 million effective 10/22/12 and a second of $18 million effective 10/1/13.</p>
</div></div></div><div class="field-collection-container clearfix"><div class="field field-name-field-sidebar field-type-field-collection field-label-above"><div class="field-label">Sidebar:&nbsp;</div><div class="field-items"><div class="field-item even"><div class="field-collection-view clearfix view-mode-full field-collection-view-final"><div class="entity entity-field-collection-item field-collection-item-field-sidebar clearfix">
<div class="content">
<div class="field field-name-field-sidebar-title field-type-text field-label-above"><div class="field-label">Sidebar Title:&nbsp;</div><div class="field-items"><div class="field-item even">How the Survey Was Conducted</div></div></div><div class="field field-name-field-sidebar-body field-type-text-long field-label-above"><div class="field-label">Sidebar Body:&nbsp;</div><div class="field-items"><div class="field-item even"><!--smart_paging_autop_filter--><!--smart_paging_filter-->As in prior years, this year’s survey covers cost of equity capital determinations by state public utility commissions (PUC) during the period Sept. 1, 2012 through Sept. 1, 2013. The survey methodology remains similar to past years – Fortnightly surveyed regulators and utility financial officials to learn the results of recent rate proceedings. Direct examination of the commission rate orders, when available, provided additional information.
The traditional cost-of-service rate case remains the most obvious source of information on how utility regulators view the issue of shareholder earnings requirements. Nevertheless, performance-based rate plans, periodic earnings reviews, and special proceedings to determine revenue requirements for restructured electric delivery-only utility operations also contain findings about the appropriate ROE for utilities, and are reported herein. Explanatory notes are provided, along with citations for orders published in Public Utilities Reports, Fourth Series (PUR4th).–PC</div></div></div> </div>
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</div></div></div></div></div><div class="field field-name-field-article-category field-type-taxonomy-term-reference field-label-above clearfix"><h3 class="field-label">Category (Actual): </h3><ul class="links"><li class="taxonomy-term-reference-0"><a href="/article-categories/roe-survey-database-0">ROE Survey &amp; Database</a></li><li class="taxonomy-term-reference-1"><a href="/article-categories/rate-cases">Rate Cases</a></li><li class="taxonomy-term-reference-2"><a href="/article-categories/roe-survey-database">ROE Survey &amp; Database</a></li><li class="taxonomy-term-reference-3"><a href="/article-categories/bonds-debt-markets">Bonds / Debt Markets</a></li></ul></div><div class="field field-name-field-members-only field-type-list-boolean field-label-above"><div class="field-label">Viewable to All?:&nbsp;</div><div class="field-items"><div class="field-item even"></div></div></div><div class="field field-name-field-article-featured field-type-list-boolean field-label-above"><div class="field-label">Is Featured?:&nbsp;</div><div class="field-items"><div class="field-item even"></div></div></div><div class="field field-name-field-department field-type-taxonomy-term-reference field-label-above clearfix"><h3 class="field-label">Department: </h3><ul class="links"><li class="taxonomy-term-reference-0"><a href="/department/commission-watch">Commission Watch</a></li></ul></div><div class="field field-name-field-image-picture field-type-image field-label-above"><div class="field-label">Image Picture:&nbsp;</div><div class="field-items"><div class="field-item even"><img src="http://www.fortnightly.com/sites/default/files/1311-CW.jpg" width="800" height="537" alt="" /></div></div></div><div class="field field-name-field-fortnightly-40 field-type-list-boolean field-label-above"><div class="field-label">Is Fortnightly 40?:&nbsp;</div><div class="field-items"><div class="field-item even"></div></div></div><div class="field field-name-field-law-lawyers field-type-list-boolean field-label-above"><div class="field-label">Is Law &amp; Lawyers:&nbsp;</div><div class="field-items"><div class="field-item even"></div></div></div><div class="field field-name-field-tags field-type-taxonomy-term-reference field-label-above clearfix">
<div class="field-label">Tags:&nbsp;</div>
<div class="field-items">
<a href="/tags/anomaly">Anomaly</a><span class="pur_comma">, </span><a href="/tags/return-common-equity">Return on common equity</a><span class="pur_comma">, </span><a href="/tags/roe">ROE</a><span class="pur_comma">, </span><a href="/tags/rate-case">rate case</a><span class="pur_comma">, </span><a href="/tags/connecticut">Connecticut</a><span class="pur_comma">, </span><a href="/tags/alabama">Alabama</a><span class="pur_comma">, </span><a href="/tags/federal-energy-regulatory-commission">Federal Energy Regulatory Commission</a><span class="pur_comma">, </span><a href="/tags/ferc">FERC</a><span class="pur_comma">, </span><a href="/tags/discounted-cash-flow">Discounted cash flow</a><span class="pur_comma">, </span><a href="/tags/dcf">DCF</a><span class="pur_comma">, </span><a href="/tags/equity-capital">equity capital</a><span class="pur_comma">, </span><a href="/tags/rate-base">rate base</a><span class="pur_comma">, </span><a href="/tags/rate-return-0">rate of return</a><span class="pur_comma">, </span><a href="/tags/reasonableness">reasonableness</a><span class="pur_comma">, </span><a href="/tags/us-treasury">U.S. Treasury</a><span class="pur_comma">, </span><a href="/tags/great-recession">Great Recession</a><span class="pur_comma">, </span><a href="/tags/michael-cianci">Michael Cianci</a><span class="pur_comma">, </span><a href="/tags/neto">NETO</a><span class="pur_comma">, </span><a href="/tags/investor-sequester">Investor Sequester</a><span class="pur_comma">, </span><a href="/tags/michael-burr">Michael Burr</a><span class="pur_comma">, </span><a href="/tags/united-illuminating">United Illuminating</a><span class="pur_comma">, </span><a href="/tags/purpa">PURPA</a><span class="pur_comma">, </span><a href="/tags/capm">CAPM</a><span class="pur_comma">, </span><a href="/tags/capital-asset-pricing-model">capital asset pricing model</a> </div>
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Sun, 03 Nov 2013 01:41:46 +0000meacott16879 at http://www.fortnightly.com